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Nassim Taleb makes the following assertion in Dynamic Hedging:

A put on yields is a call on bonds, a matter of confusing importance.

But I struggle to understand why that is the case.

If I buy a put, I hope that the underlying falls. If bond yields go down, I assume that the price of bonds also goes down, so a put (not a call) on bonds is the one that is desirable.

Or did he mean interest rate yields set by the government?

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  • Can you provide additional details or perhaps a link? Jun 22 '20 at 22:37
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    If the price of a bond goes down, the yield goes up, and vice-versa - because the bond has a fixed coupon and par value to be repaid at maturity, so if you can buy that stream of income cheaper, your rate of return will be higher. Jun 22 '20 at 22:49
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If a $1 grows at an annual rate of r, the value after T years is (1+r)^T. Bond prices work in reverse: how much is a future cashflow worth today?

Today's Balance * (1+r)^T = Future Balance
Today's Balance = Future Balance / (1+r)^T

The denominator on the right side of the second equation increases as r increases. A higher interest rate results in a lower price.

Suppose an investor paid $100 for a treasury bond that pays a 1% coupon. If tomorrow the treasury offered to sell a bond for $100 with the same maturity, but a 2% coupon; how much would the investor be willing to sell the 1% coupon bond for? Less than $100 because the new bond pays a higher coupon and is available for $100. The price of a 1% coupon bond would have fallen if the market interest rate increased.

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  • I don't follow how an explanation of the inverse relationship of bond price and yield relates to Taleb's Dynamic Hedging which involves options. However, that connection was not made clear by the OP. Jun 23 '20 at 13:15

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